prev

The Great Machine

This note was originally published at 8am on November 20, 2013 for Hedgeye subscribers.

“Unlike an inexorable, Newtonian “great machine”, the economy is not a closed system.”

-Geoger Gilder

 

That’s a quote from the end of lucky chapter 13 of one of the best markets/economics books of 2013, Knowledge and Power, by George Gilder. I like this book because it’s the precise opposite of what your central planning overlords @FederalReserve think.

 

Yesterday, at the Keynesian-economics-Club-of-Washington-D.C. event, Ben Bernanke proclaimed his mystery of faith to his head nodders: “the surest path to recovery” is for the Fed to do more (read: no taper).

 

Right, right. It’s a good thing he’s sure.

 

Back to the Global Macro Grind

 

This, of course, is the basic divide between how most of us market-practitioners think about markets/economies versus some un-elected and unaccountable academic theorist does. Core to Fed group-think is certainty whereas what we do is embrace uncertainty.

 

Markets and economies aren’t some theoretical “great machine” that behaves in “equilibrium.” Markets and economies are dynamic and non-linear. Anyone who has studied history understands that.

 

I’ve been on the road seeing clients in Los Angeles and San Francisco this week. I’ll be in Vegas tonight and Phoenix tomorrow. No matter where I go, I get the same feedback from market-practitioners about Fed policy – uncertainty.

 

At the same time, these dudes (and dudettes) backslapping one another at the Fed think that they have this completely under control. At one point yesterday, Bernanke said that his “forward rate guidance is helping the economy.”

 

Pardon?

 

Taper, no-taper, taper, no taper, maybe-taper, no taper, change goal posts on taper, don’t taper…

 

It’s a certified circus at this point.

 

The smartest investors I meet with have the humility to tell people that they have no idea how this ends. So that’s comforting, right? Not only one of the sharpest clients we have, but one of the best performers in 2013 YTD, summarized that this he-said-she-said-taper-talk thing has given him a tremendous amount of conviction in one position – cash.

 

“Keith, with all of the illiquidity and policy risk factors building out there, I really like cash.”

 

Indeed.

 

After effectively day-trading Yellen’s predictable behavior last week, I’ve gone from 48% cash in the Hedgeye Asset Allocation Model to 60% this morning. But I was at 66% cash yesterday morning, and bought-the-damn-bubble in a few things on red again yesterday.

 

Day-trading? Yep. I have no problem with that. Do you? #GetActive

 

I realize its below these uber intellectual types at the “Economics Club of Washington” to risk manage (read: trade) the market risk they are superimposing on us every day. And I kind of like that. Maybe they’ll label me a lower-class-trader, or something like that.

 

Moving along…

 

What’s my call? It’s been a fantastic year to be long US #GrowthAccelerating (from 0.14% GDP with the SP500 at 1360 in Q412 to 2.84% GDP Q313 and US stocks at all-time highs), and now, on up days, it’s time to raise cash.

 

Looking at both real-time market indicators (Russell2000 growth has been making lower highs since locking in its all-time high on October 29th) and high-frequency economic data, it appears to us that the slope of the line on US growth is peaking.

 

Since what happens on the margin matters most, if and when the US economy slows (from here) to say 2% (or 1.6%, which is now the downward bound in our GIP model for US GDP Growth in 2014), what do you think the top performing Style Factor in US Equities (GROWTH) is going to do?

 

No worries, you don’t have to guess – that style factor is already starting to do what you should expect it to do – slow. As US equity market momentum slows (on lower and lower volumes), both the Fed and its nodders are going to get lulled to sleep.

 

Moreover, I think the Fed will cheer on the #GrowthSlowing data as more reason not to taper… and, in doing so, they’ll suck in every last lemming who hasn’t been long US stocks in 2013 to buy the bubble.

 

How messed up is that? I have no idea on timing, but oh how this “great machine” of Keynesian certainty is going to fall.

 

Our immediate-term Risk Ranges are now as follows:

 

UST 10yr Yield 2.67-2.81%

SPX 1778-1809

VIX 11.85-13.88

USD 80.48-81.36

Brent 103.68-108.69

Gold 1260-1303

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

The Great Machine - Chart of the Day

 

The Great Machine - Virtual Portfolio


$JCP (and McGough) Stick It to the Bears

Takeaway: We're surprised at how many people are hanging on to the stale bear case on JCP. At least acknowledge that things are improving.

CNBC is going to have a tough time carting out a bull on JC Penney. Hedgeye retail analyst Brian McGough is the only one. And he's nailing it.

 

The stock market pinata turned the tables on JCP bears after the bell, pulling a double-digit same store sales rise out of the bag for November. The stock surged higher and was the most actively traded in the after-hours session.

 

$JCP (and McGough) Stick It to the Bears - jcp1

 

As McGough wrote in a note to clients earlier this evening, "We're surprised at how many people are hanging on to the stale bear case. At least acknowledge that things are improving." McGough says he is the first to admit that it's only a partial window into the quarter. But, as he says, "This news validates three core parts of our JCP thesis."

  1. There are so many things at JCP that are broken, but absolutely none of them are beyond repair. Consensus won't acknowledge the concept of JCP earning money, while we think that $1.50 in earnings power is within reach (that's up from our recent $1.30 estimate). Once people internalize this eventuality, we think we're looking at a $20 stock (low teens multiple, though we could argue higher).
  2. Even though Wall Streeters may not be big JC Penney shoppers, the fact of the matter is that the average American consumer genuinely wants JCP to exist. Tough for Wall Street to believe, but our work suggests that it's 100% true.
  3. JCP is absolutely gaining share -- when it comps 10% -- 3-5x its average competitor -- it's tough to argue otherwise.

The news gets worse for JCP bears.


$JCP (and McGough) Stick It to the Bears - JCP tail

Hedgeye CEO Keith McCullough points out that there's no resistance to the TAIL (mean reversion) line of $14.61. That represents 40-50% upside.

 

(Click here to subscribe to Keith McCullough's Real-Time Alerts. As of this writing, he has registered a remarkable seventeen winning trades in a row.)

 

 


JCP: The Bear Case Lacks Intellectual Integrity

Takeaway: We're surprised at how many people are hanging on to the stale bear case on JCP. Seriously, at least acknowledge that things are improving.

Great news out of JC Penney this evening, as the company reported a 10.1% comp in November.  We admit that it's only a partial window into the quarter. But, this validates three core parts of our JCP thesis.

 

  1. There are so many things at JCP that are broken, but  absolutely none of them are beyond repair. Consensus won't acknowledge the concept of JCP earning money, while we think that $1.50  in earnings power is within reach (that's up from our recent $1.30 estimate).  Once people internalize this eventuality, we think we're looking at a $20 stock (low teens multiple, though we could argue higher).
  2. Even though Wall Streeters may not be big JC Penney shoppers, the fact of the matter is that the average American consumer genuinely wants JCP to exist.  Tough for Wall Street to believe, but our work suggests that it's 100% true.
  3. JCP is absolutely gaining share -- when it comps 10% -- 3-5x its average competitor -- it's tough to argue otherwise.

 

*Our research is based in part on our survey work -- which suggested last month (before KSS missed and JCP beat 3Q) that JCP was regaining share, and that KSS was likely the biggest donor.  We've updated our survey, and will be ready to share our insight (and incremental trends from our last survey) early next week. Please contact sales@hedgeye.com if you are interested in the results.

 

BEARS ARE STILL GROWLING

 

We've gotten a lot of feedback from bears this evening -- including 1) 'they were up against an easy comp' and 2) 'we don't know inventory levels or gross margins.' The latter point is true. We don't know margins. But we have a rather strong sense that they were better than last year.  We still think that a return to the  mid-high 30s Gross Margin is likely -- from the depths of the 22% where Johnson forced them. We need to keep in mind that Gross Margin is one of the easiest lines to destroy on the P&L over a short period of time (i.e. Ron Jon eliminating $2.5bn of 48% GM private label). But unlike other industries, in retail it is also the one line where you can shake the etch-a-sketch clean and return to meaningfully higher levels over a 12-18 month time period.

 

As it relates to the bears' 'it's irrelevant -- it was an easy comp' argument, we think that's an absolutely ridiculous point. The reality is that last year JCP lost a tremendous amount of market share -- $4.3bn to be exact.  And now it's taking it back. When they take it back from KSS -- who we estimate stole $800mm in sales -- is KSS going to say…'that's ok, we took a lot of share last year, so it's ok if our sales are down.' Yes, we know how ridiculous that sounds. But the reality is that JCP is growing 3-5x ahead of its competitors. And that can't be glossed over.

 

Here's A Chart That Shows Us Who Took The Most Share From JCP. As Noted, Our Updated Survey Hits Next Week and We Will Be Able To See Incremental Trends

 

JCP: The Bear Case Lacks Intellectual Integrity - JCP

 

HERE'S ONE OF THE MOST IMPORTANT CONSIDERATIONS AS IT RELATES TO OUR BULL CASE

 

First, as a precursor, we need to reiterate that we are in no way perma bulls on JCP (we're not 'perma' on anything). We were short this name at $42 when Ackman was parading around his $12 in earnings thesis. We turned positive earlier this year when we thought perception of fundamentals as well as sentiment had overshot on the downside.

 

As it relates to earnings power, let’s keep an important factor in mind…JCP is operating at $100 per square foot. That’s embarrassing. Kohl’s, which we think has structural issues and has been at the top of our short list – is running close to $210/sq ft. Before Johnson worked his magic, JCP peaked at $190 per foot.

 

Our point here is that we don’t have to assume that JCP becomes a great retailer. We don’t have to even believe that it will be an average retailer.  It can remain in the lower quartile – a notch above Sears even – and operate at $140/square foot. And it can get there by simply fixing some of the factors that Johnson damaged during his triumphant reign.

 

Alongside $140/square ft., our other key assumption is that Gross Margins get back to 37%, which we think is very doable – despite the severe pushback we get on this assumption. Ron Johnson decimated JCP’s private label brands, which cost the company about $1bn in gross profit – that’s what happens when you remove $2.5bn in sales at a 48% gross margin and substitute that with $900mm at a 33% gross margin.  

  

Here are some of our recent clips from HedgeyeTV. Comments are welcome, as always.

 

http://app.hedgeye.com/media/704-video-jcp-mcgough-remains-optimistic

 

http://www.youtube.com/watch?v=nfMU0ggmJ1U&feature=share&list=UUkDxvN-bcxsKkvJ3yyiGSVQ

 

Here's Our Note After JCP Surprised on the Upside With 3Q Results Last Month

11/21/13

JCP: The Bear Case Just Shrunk

 

Takeaway: This is going to be the Q where people look back and say “yeah, that was the point where I should have realized JCP is a viable entity.”

 

The list of ‘what’s changed’ to our thesis on JCP in the wake of its print is a very short one. In fact, it’s nonexistent. Were there questions that emerged that we need to get answered? Of course there were. That’s what happens when a company loses $1.94 per share. But far more questions were answered than were raised. Here’s some of our thoughts.

 

  1. EPS of ($1.94) missed the Street’s ($1.70) but the reported number includes a $0.73 loss associated with a tax valuation allowance. We don’t think EPS was the most relevant statistic this quarter as share count estimates were all over the place given the mid-quarter equity offering. Nonetheless, on an adjusted basis, we’d say that they probably beat.
  2. By now everyone knows that JCP voluntarily repaid $200mm on its revolver. It’s worth reiterating as that’s not behavior one would expect from a company about to file Chapter 11.
  3. Guidance for 4Q includes; a) additional sequential improvement in top line and gross margin – and both positive vs last year, b) DOWN sg&a versus last year, and liquidity to be in excess of $2bn. We don’t think that down SG&A is sustainable for any extended period of time – nor do we want it to be. But for now, we’ll take it.
  4. That point on liquidity guidance is the most important. The big bears out there had estimates for year-end liquidity of $1.5bn to $1.8bn. Again, companies with stocks going to zero don’t take up liquidity expectations.
  5. One of the biggest factors we had to rectify is the fact that gross margins were weak at the same time the company brought back higher-margin private label. But what we did not consider is the fact that JCP is still dealing with merchandise that was ordered under Johnson’s regime – brands that the consumer simply does not want. This is product that is going out at a gross margin in the 15-20% range. That’s seriously offsetting the high-40% GM JCP realizes on private brands like Arizona, Worthington, and St. John’s Bay. We did extensive consumer survey work around these brands – and although most people reading this note might not want them, the average American definitely does.

 

In the end, this is going to be the quarter where people look back and say “yeah, that was the point where I realized JCP wasn’t going under”.  We know that this isn’t a major bullish statement, but it certainly removes the most bearish case being throw around – and that’s the case that nearly every short is banking on (and yes, JCP remains one of the most heavily shorted stocks in the S&P). People are still going to have to buy in to the premise that this company can see an acceleration in sales/square foot to a level that can sustain a respectable earnings level. We think JCP pierces through $120/ft in 2015 – which will mark its break-even year. That might not sound too enticing – after all, we all like for companies to make money instead of simply not lose money. But the consensus is at a loss of $1.18 that year, and we think that estimates will need to come up materially.


Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

#CyberMonday Goes Mobile

Takeaway: Department stores crushed it with 70% growth.

Editor's note: Hedgeye Retail Sector Head Brian McGough shares some of his thoughts on Cyber Monday.

#CyberMonday Goes Mobile  - cybmon

 

Cyber Monday Goes Mobile With 55 Percent Sales Growth, Reports IBM

  • "U.S. shoppers made Cyber Monday the biggest online shopping day in history with a 20.6 percent increase in online sales, according to the latest cloud-based analytics findings from IBM. Mobile sales led the way, exceeding 17 percent of total online sales, an increase of 55.4 percent year-over-year."
  • "Cyber Monday also capped the highest five-day online sales period on record – from Thanksgiving Day through Cyber Monday – which grew 16.5 percent over the same period in 2012."
  • "Department Stores: Cyber Monday total online sales grew by 70.3 percent over 2012, with mobile sales growing 52 percent year-over-year. Average order value was $161.83, up 18.7 percent year-over-year." 
  • "Health and Beauty: Cyber Monday total online sales grew by 65.1 percent over 2012, with mobile sales growing 84 percent year-over-year. Average order value was $60.22, an increase of 6.8 percent year-over-year."
  • "Home Goods: Cyber Monday total online sales grew by 26.5 percent over 2012, with mobile sales growing 40.5 percent year-over-year. Average order value was $182.19, an increase of 9.2 percent year-over-year."
  • "Apparel: Cyber Monday total online sales grew by 22.5 percent over 2012, with mobile sales growing by 58.3 percent year-over-year. Average order value was $102.83, a decrease of 6.9 percent year-over-year."

Takeaway: Some interesting color here by IBM. Department stores crushed it with 70% growth, which is great, because they fell flat on their face as it relates to in-store shopping. Let's also put the dot.com spend into perspective…most stores are coming off an fairly low level of spending online. About 10% of total retail sales originate on-line, but department stores are only about 7% (despite the fact that virtually everything they sell is e-commerce friendly). Big sign of failure to capitalize on an opportunity, but also a big opportunity from here. JC Penney, for example, lost about $500mm in dot.com sales over the past two years (thanks RonJon), or about a third of its internet business. We think it gets it back within 2-3 years.  

 

#CyberMonday Goes Mobile  - nnn7

 

For more information on how you can subscribe to Hedgeye research please click here.


ISM: Nice Upside Surprise

Takeaway: ISM of 57.3 for November surprised on the upside.

Yesterday's headline ISM reading for November improved +0.9 month-over-month to 57.3, marking another year-to-date high and the highest reading since April of 2011. 

 

Strength was pervasive across the sub-indices as the New Orders and Employment series hit their highest levels since April 2011 and April 2012.  Supplier Deliveries remained unremarkable at a middling 53 while inventory levels improved to 50.5 in November from 52.5 prior.   Reported respondent commentary was generally positive as well (Here)

 

ISM: Nice Upside Surprise - gm5

 

Whether incremental strength in November could be partially attributed to deferred demand coming back online post the government shutdown resolution in October remains equivocal.  While October durable goods data showed a discrete deceleration, headline ISM advanced in October with Business Production, New Orders and Employment declining only modestly. 

 

Notably, in the ancillary index aggregates, backlogs continued to rise and the export index advanced for a third straight month (highest since Feb 2012) as demand from outside the U.S. continues to support domestic manufacturing activity. 

 

It’s not particularly surprising to see manufacturing gains outpace services gains domestically with household personal income and spending growth still constrained (largely stemming from sequestration and ongoing negative government employment growth) and European growth accelerating.  

 

While any reading >60 is solid, we’ll be interested to see if New Orders can make a higher high in December or if we get a repeat of August and another short cycle top as we head into the 2014 iteration of the budget/debt ceiling tragicomedy.   

 

In the more immediate term, with the dollar correlation to equities holding moderately negative, the market remains largely myopic in its focus on the implications of the macro data for prospective policy adjustments.  

 

ISM: Nice Upside Surprise - ism1

 

* * * * * * * 

 

For more information on how you can subscribe to Hedgeye research click here.


Just Charts - #EuroBulls

Our Top Q413 Global Macro Theme remains #EuroBulls.

 

The heart our #EuroBulls call is a bullish position on the GBP and EUR versus the USD and a bullish position on UK and German equities, built on a few central factors:

  • Central Bank Intervention: we expect Janet Yellen to remain the ueber dove on policy and push out any QE taper expectations to at least late in Q1 2014, which should burn the Greenback lower (etf UUP). 
  • BOE “Hawks”: we expect Mark Carney and the BOE to remain on hold with interest rates and the asset purchase target, built on improving UK fundamentals, which should encourage the British Pound higher (etf FXB).
  • Draghi’s Back Pocket: we were surprised (and off-sides) with the ECB’s decision to cut the interest rate 25bps on 11/7. The cross has since corrected and we like the set-up on the long side. Twisting an expression, we don’t think it pays to ‘Fight the ECB’: Draghi has balance sheet flexibility with LTRO repayments to unlock additional sovereign and banking bailouts, if needed (etf FXE).
  • Island Insulation: the UK was the first country to issue austerity in Europe -- we’re seeing the threw-put of that decision with fundamentals improving ahead of its European peers. We maintain a bullish bias on UK equities (etf EWU).
  • German Leadership: Chancellor Merkel is formalizing coalition talks with the SPD; alongside her Finance Minister Schaeuble we see strong continuity of policy vis-à-vis the EU with the new coalition. We’re seeing strong domestic economic health from Eurozone’s largest economy and we expect the country to benefit as the region recovers off a low base. We’re buyers of Germany’s stability (etf EWG).

Just Charts - Below we show the data we’re seeing that is supportive of our #EuroBulls call:

  • GDP Taking the Turn: before we highlight the economies of Germany and the UK, we’ll note that we’re seeing a broader improvement from the Eurozone region. In the next charts, the turn (to the positive) is underway!

Just Charts - #EuroBulls  - zz. eurozone imports and exports

 

Just Charts - #EuroBulls  - zz. eurozone IP and REtail

  • Confidence Ramping: From economic to business and consumer, the improvement in confidence readings is hard to ignore.

Just Charts - #EuroBulls  - zzz. .eurozone business conf

  • Even Autos are getting a bounce: Any increase in big ticket items is a signal of confidence to us.

Just Charts - #EuroBulls  - zz. EU clunkers

  • PMIs Popping: the improvement in confidence is backed by stronger Services and Manufacturing PMIs.  Despite underperformance from France, we expect the Eurozone aggregate to cruise about the 50 line (expansionary), and the UK and Germany to outperform.

Just Charts - #EuroBulls  - zz. pmis

  • Risks Abates: an additional positive signal comes from tightening credit spreads, approaching levels last seen when Europe’s sovereign ‘crisis’ began.  While risk is not completely off the table, either on the sovereign or banking sides, we’re seeing compelling improvements. All European sovereign CDS are down on the month and, on average, European Financials have tightened by 46 bps or roughly 21% on the month. 

 Just Charts - #EuroBulls  - zzz. credit spreads

  • Deflating the Inflation: we view deflation of the inflation as a lower consumption tax that will boost real inflation adjusted growth. Clearly the ECB has failed to meet its mandate of CPI at or below 2%, however CPI at its current 0.9% is not a “threat” of deflation in our opinion.  Despite the ECB’s surprise cut to the interest rate on 11/7, we see no need for the central bank to cut further as fundamentals are showing improvements.       

Just Charts - #EuroBulls  - zz. Eurozone inflation

  • Draghi’s Back Pocket: Our new mantra is don’t ‘Fight the ECB’ because 1). Time and time again it has not paid to, and 2). Draghi has even more balance sheet flexibility now with LTRO repayments coming in. Don’t forget our central position has been that Eurocrats want to keep the Eurozone experiment alive – this includes at all costs, be it for additional sovereign and/or banking support. 

Just Charts - #EuroBulls  - zz. ECB and LTRO

  • Credit Thin: This chart remains a thorn in Draghi’s side. Getting credit to flow into the system to households and non-financial corporations has been a great challenge. We don’t expect the ECB to issue another round of LTRO, given its shortcomings in this respect, but we could foresee an alternative to the LTRO with more outlined lending requirements. 

 Just Charts - #EuroBulls  - zz. ecb loans to households

  • The TREND is Your Friend: our quantitative lines in the sand on the EUR/USD have not moved much in Q4. The currency crashed on Draghi’s unexpected rate cut on 11/7. It has since rebalanced and we like it on the long side as fundamentals improve and the EUR marginally wins out versus the USD in the #CurrencyWars (etf FXE). 

Just Charts - #EuroBulls  - zzz. eur usd levels

  • UK GDP: we expect outperformance versus most of its European peers, built largely on it choking down austerity first during the great recession.  The European Commission in its autumn report recently raised UK GDP expectations, to +1.3% in 2013 from +0.6% and to +2.2% in 2014 versus a previous estimate of +1.7%. We’re buyers of UK equities (etf EWU).

Just Charts - #EuroBulls  - zzz. uk gdp

  • UK CPI Eases: Inflation has moderated to 2.2%. We think this is an added benefit to consumers and expect a #StrongCurrency to increase purchasing power by deflating imported inflation.

Just Charts - #EuroBulls  - zz. uk cpi

  • UK Confidence Confirms the Data, or visa-versa: We see confidence rising alongside high frequency data: Manufacturing PMI for November was the best in in Europe (58.4 versus 56 in October). And Construction PMI shot up to 62.6 vs 59.3 in October.

Just Charts - #EuroBulls  - zz. uk confidence

  • UK Manufacturing and Retail Sales: confidence is a huge piece of the consumption puzzle; we see the trend in manufacturing and retail sales moving positively over the intermediate term. Household spending accounts for 62% of GDP in the UK. 

Just Charts - #EuroBulls  - zz. uk IP vs RETAIL

  • UK Housing May Ease: After taking off like a rocket ship for the balance of the year, the BOE announced on November 28th that it would curtail mortgage lending in its “funding for lending” scheme. 

 Just Charts - #EuroBulls  - zz. uk housing

  • GBP/USD: the cross is trading comfortably above over our intermediate term TREND level of support of $1.59 and long term TAIL line of $1.57 (etf FXB).

Just Charts - #EuroBulls  - zzz. gbp usd

  • Strong Germany: we continue to like the DAX, on a positive correlation to the EUR/USD. Fundamentals remain grounded with a low unemployment rate (6.9% vs 12.1% in the Eurozone), CPI at 1.6% Y/Y, expanding exports, strong PMIs and consumer and business confidence, and an inflection in factory orders to the upside (etf EWG). 

Just Charts - #EuroBulls  - zz. germany factory orders

 

Just Charts - #EuroBulls  - zz. germany ifo

 

Just Charts - #EuroBulls  - zz. germany zew

 

Just Charts - #EuroBulls  - zzz. dax vs eur

 

 

Matthew Hedrick

Associate

 

 

 


Attention Students...

Get The Macro Show and the Early Look now for only $29.95/month – a savings of 57% – with the Hedgeye Student Discount! In addition to those daily macro insights, you'll receive exclusive content tailor-made to augment what you learn in the classroom. Must be a current college or university student to qualify.

next